Monday, September 29, 2008

Market Rallies to the Close

SUMMARY:- Market holds up surprisingly well given the day's issues, then rallies to the close, anticipating a deal this weekend.- Final Q2 GDP backslides below 3%. Likely shades of things to come.- How about some outside of the box thinking versus Washington as usual?- Waiting on our leaders to craft a plan so market can get on to the next task.

Market marks some time, not bad given the environment.

The session started lower as expected, but in the end the market rebounded to close basically flat, at least outside of the Dow as that index surged higher as its financial components performed well, some rocketing higher. Oil was basically flat (106.96, -1.06) and gold as well (883.40, +1.40). Bonds closed lower, but they were up off of the early lows, somewhat splitting the baby though once more all the action was in the short end as it sees more quick money than a night clerk at an hourly rate hotel in the red light district (2.11% on the 2 year, down from 2.18% Thursday but up from 2.01% on the open).

The ability to bounce and close near flat to higher was somewhat impressive given the landmines laid out. The largest bank failure in US history was viewed as a positive, at least for the strongest banks. JPM, already owning Bear Stearns' assets, picked up WM's deposits for $1.5B, just pennies on the dollar. JPM surged 11% on the session. WFC surged as well as it is expected it will be called upon to 'assist' with another bank this weekend, picking up some great assets for nothing. There was also the lack of a bailout plan and the rancor that developed Wednesday with legislator infighting. I found it humorous and yet annoying when in a single sentence some would call for bipartisan spirit and then blame others for grandstanding or some other. Business as usual I suppose. RIMM missed on its earnings and was slaughtered to the tune of 27%, dragging the large cap techs down with it. The final report on Q2 GDP slipped below 3% (2.8% versus 3.3% in the prior iteration) as the effects of the credit freeze start to show up in the economy much more and sooner than expected. Even with a bailout package this is not likely to improve anytime soon as the damage is done and the credit markets have to normalize before the economy can even begin to get back on track and improvement begins.

Plenty of news to move the market, news that would have yanked its chain pretty hard on a typical session. But Friday, even though the lack of a deal on Thursday helped set a negative mood, the prospect of a new day and a new bailout deal to come kept things under control. Indeed, as the day wore on and no deal was forthcoming, it apparently was assumed that a deal would then come over the weekend. That sparked a late rally in anticipation, aided by some short covering just in case. It was not all short covering, however, as the big name financials took off to the upside late. Can't short them so it was buyers anticipating a bailout deal and other deals with other banks over the weekend as the credit and mortgage stress forces banks down. A suspension of the mark to market rules while awaiting a bigger deal seems to make sense, but no one is talking about that. In any event, the market rebounded and we used that to buy some more WFC, one of the few, the proud, the benefactors of no bailout deal as the smaller banks fold one by one (at least for now; may be 2 by 2, 5 by 5 or more if nothing is done). In sum, it was a day of waiting on a plan with that overriding all of the negatives, enough so that the market rallied late.

TECHNICAL. Intraday action was positive with a lower start followed by a solid recovery and sprint to the close. Not reading too much into this as everything is skewed by the external force of $700B in taxpayer money or a privately funded insurance program.

INTERNALS. The market turned off its lows but as usual breadth lagged the move with NYSE logging -2:1. NASDAQ more matched its flat close with decliners leading 1.4:1. Volume was mixed, up on NASDAQ, down on NYSE. NASDAQ volume jumped after the RIMM earnings and explosive volume. Some distribution in the techs.

CHARTS. Gapped lower on NASDAQ while the NYSE indices opened and immediately tanked. They held above the September low hit the prior week then rebounded back to near resistance at the 10 day EMA for NASDAQ and SP500, the 18 day EMA for DJ30. Trying to make higher lows but no change of character . . . still. NASDAQ remains at the prior 2008 lows before the September dive while SP500 remains at the July low, its prior 2008 low before, again, the September decline. They can bounce on news such as a bailout, but the patterns are still overall weak. DJ30 is trying to emerge as a leader with something of a double bottom trying to form up. As noted last week, it will have to take the reins as the other indices are struggling. A bounce on the indices will have to be a serious move to change their character.

LEADERSHIP. Energy may have been trying to form up but it did not carry the ball Friday. Financials had the best session, and most of the glory went to the biggest and the best in the group. Medical and healthcare held up very well though they were not breaking upside. The leaders in consumer related, early cycle stocks remain under pressure. Homebuilders, however, while up and down on the week, are still in good position. Some dropping out, others hanging on. Once the 'deal' is done we will see if the ones hanging in are really strong and can provide real breakouts. In this market you have to start viewing all stocks skeptically.

SUMMARY. The action on the week was driven by the Feds and their bailout plans. Economic and other more typical forces took a back seat as the credit lock up worsened again as the deal for a bailout came under pressure late in the week. It is much harder to invest in this kind of market and trading is tough as well. Once there is a plan in place the market will likely gush with delight and jump higher. After that initial jump it will be back to the reality of dealing with an economy hard-pressed after the credit freeze harmed so many businesses and now individuals seeking loans for anything. A lower Q3 growth rate and now many saying a negative Q4 GDP are looming. The market will handicap how long this will last as it looks out 9 to 12 to 15 months down the road. It just made a new low for this down cycle so there is still work to do even if this bailout proves to be the game changer and helps set the floor in the bear market. History tells us, however, that even when a deal is in place, after the short term 'rah rah' the harsh reality, the reason for the bailout has to be dealt with. Thus after a relief bounce, the near term is likely more downside and more volatility. Of course the market has the final word and how it and the leading sectors perform will tell that story. Who knows, perhaps the financials will use a bailout plan to finally take the lead that they have to take in order for any recovery to be successful.

THE ECONOMY

The bailout plan: too late to do the right thing? Why not some outside the box thinking?

I am going to digress here for a few paragraphs before I get to what should be done. Bear with me or skip ahead 5 paragraphs.

While both sides are, as usual, acting rather childish and hardly working with clean hands with respect to any rescue package, I was particularly taken Friday by Barney Frank's comments regarding the House republican plan. Not taken in the thoughtful, touched sense, but as in taken aback. Frank deemed the House republican plan 'irresponsible' because it came late - in his opinion of course. No statement that it was not a good plan or that the Paulson plan was better. The only support he offered for his position is that Paulson and Bernanke had brought it, that some unnamed experts supported it, and they had all invested a lot of time on it. Thus it must be a good one.

There is an old saying about throwing good money after bad. Who cares if a lot of time is invested in something if it proves to be the wrong idea or a better idea emerges? Is it, as Frank's comments suggest, too late to do the right thing? Is it irresponsible to push for what is right even if it emerges late in the game? Frank's comments were asinine.

They were also hypocritical. He calls for bipartisan support at all costs and in the same sentence chides House republicans and others for grandstanding and not going along with the plan in place as if its position in time holds some special powers. More importantly, however, with all of the talk of bailing out Main street and protecting the taxpayer with requiring equity interests, salary caps, etc., his party loaded the bill with pork favors to groups of questionable repute such as ACORN that currently has some of its higher ups serving jail time for fraud. Not even considering the shady character of these groups, why on earth would they be receiving funds taxpayers, the underwriters of this $700B socialist pig (no lipstick on this one), should be receiving, not in the form of reducing the budget or some new federal spending, but in hard dollars mailed back to them with a big thank you note attached.

Instead the majority party in Congress acted just as childishly and just as disdainfully as the republicans did when they had the majority. It was, once more, a disheartening display of largesse and power lust behind a smokescreen of helping the average American.

So what about the outside of the box thinking? Everyone says all financial institutions with the junk mortgages must participate for the bailout to work. Well it is clear that there is an impasse. While you may not agree with the House republicans, bless their souls for standing up to their principles and saying the emperor has no clothes with respect to this monarchical plan. But they need to get with the program as well because they are not going to get their way in favor of the plan that Frank has invested so much time, albeit wasted time in my opinion, with his government grab plan (that was a Paulson/Bush power grab plan before modified into a socialist power grab plan).

What they need to press for is a dual methodology for gaining assistance with the bad loans. For those that are truly heading down the toilet, the RTC-like plan swings into action. They get their junk bought by the Treasury and as they were so desperately in trouble they give up some equity to 'protect the taxpayer' though as we have seen that was going to pet groups and projects. Didn't we just go through this debate recently and yet when the country is in a Great Depression-like crisis these jerks still put pork into bills? Despicable.

The second part of the plan would allow those institutions that are not terminal but just have a headache or the flu to buy the privately funded insurance the House republicans are calling for and in doing so do not have to give up equity: they are buying protection and not using all public funds so they don't have to allow the feds to muscle into their business. Of course it would not all be private funds as it will take quite a bit of money in the insurance pool, but again, these are not the terminal cases, just those that caught the same flu from these bad loans and the credit freeze. They can suspend dividends, suspend the mark to market requirements, get some tax credits. Some tax credits for the ordinary citizens for losses in market value of homes, for losses in the financial markets (as one reader suggest, raising the limit from 3K to $50K), etc. to restore buying demand. There are many ways to incent behavior and raise capital without spending taxpayer money. Of course you would hear the tired line that tax credits are spending but that is nonsense. Returning tax money to citizens is not spending; giving 20% of any profits to ACORN is spending.

In this manner they get a deal done because the initial price tag can be trimmed, it is not a government equity grab of every financial institution in the US that is suffering from these mortgages (and this group includes basically all of them, making the scope of this plan absolutely staggering in its expansion of federal control), there is confidence of two systems to back up the institutions, and the tax incentives help launch more

A massive federal power expansion play.

I am going to digress from plan specifics again. Be forewarned. What is behind the almost manic push for this plan is that it is the perfect way for the government to grow larger as it enters new areas that are constitutionally banished to it. The Paulson plan was dictatorial. The majority added features that it says make it fair and gives oversight. It gives oversight into the entire financial industry via warrants in the companies that use the plan, and according to Paulson, Bernanke, and many in Congress, all institutions with these bad loans need to be involved and thus give up equity. It is the perfect vehicle to extend federal powers by both law and funding. As equity owners receiving profits from both the sale of the mortgages once they appreciate as well as company earnings, the federal government has massive new funding mechanisms to grow ever larger. It also would then have the precedent to own equity and the European socialist morph of the economy would be complete.

That is what makes this such a terrible plan and why the House republicans made a stand. It clearly delineates the philosophical differences in our country about the role of government. If it passes we may as well tear up the Constitution because the government will be into everything. Ask yourself this: do you want the federal government owning shares of every financial institution in the United States and thus directing the company boards and officers and having access to every bit of information about your banking transactions? People always think of government intrusion in terms of wiretaps and spying. The real horror of Orwell's '1984' is that the all-knowing central government gains this information and power through acquiescence of the citizens as they willingly yet unwittingly open their doors to the intruder that our founding fathers tried so hard to keep closed. When this bill passes it may indeed save the financial system and thus the economy for another quarter century, but it will be likely the most tragic of the five tragic days in the Constitution's history.

THE MARKET

MARKET SENTIMENT

VIX: 34.74; +1.92. After a 42.6 reading two Thursdays back VIX fell. It will likely make another spike before this is over and then there could be a bottom over several weeks. Still way too early to determine that.VXN: 36.85; +1.99VXO: 39.41; +2.66

Put/Call Ratio (CBOE): 1.01; +0.21. Back over 1.0 on the close. 10 of 13 days over 1.0 during the selling so it has done its job.

Bulls versus Bears:

For the second time this year bears are crossing above bulls, doing so basically where they did in March on their way to much more extreme readings just about the time the market made the March low and started the last rally. Positive for the market and if SP500 is going to hold the long term trendline is the place to do it.

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 37.5%. Not much of a drop from 37.9% last week. Down, but just edging lower, indicating most don't understand the gravity of the credit situation. A dive under 35% would be a positive given the inverse nature of sentiment indicators. Down from 40.7% on the high during the rally off the July lows. Turned back up before it got down to 35%, below which is considered bullish for the market as the number of upbeat investors is relatively low. A long way up from the 27.8% on the low this round. Hit 31.9% two months back and the 30.9% low hit in March. Steep drop from a rebound high at close to 50% on the run through May. In March the indicator did its job with the dive below 35% and the crossover with the bears. Now it is going above and beyond. Bulls and bears have crossed over again, doing so even before the prior lows are hit. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 40.9%. Bears fell from 43.7%, apparently on the belief a bailout will immediately cure the market's woes. It won't but these guys will apparently need to be convinced. Unfortunately, they will likely get that education over the next several months. If the bulls turn over and crap out below 35% again that would be a strong signal. Interestingly they are still 'crossed over,' i.e. more bears than bulls. Moving toward 50.0%, the high on this move, but a long way off. As the NYSE indices test the lows you would want it higher. Still above the 35% threshold so still a bullish indication. A steady rise to 50% on this move: 48.9%, 47.3%, 44.7% and 39.3% before that. Well above the bullish level and the highest since 1995. Again, that is one of the best indications that sentiment is getting extreme on the negative side. It is again past 35%, the level that historically indicates too much pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. Up sharply from a low of 19.6% on the last rally. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that run. That June peak eclipsed the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). This is a huge turn, unlike any seen in recent history.

NASDAQ

Stats: -3.23 points (-0.15%) to close at 2183.34Volume: 1.987B (+6.02%)

Up Volume: 920.999M (-472.513M) Down Volume: 1.041B (+587.179M)

A/D and Hi/Lo: Decliners led 1.38 to 1Previous Session: Advancers led 1.48 to 1

Finished flat on Friday and below 2200, a key range/level this year, representing three bottoms more or less. Trying to make a higher low but this is still a very weak pattern with a lower high in August, a lower high in mid-September and a lower low as well. Still a lot more work to be done unless the bailout package is just so good it is a game changer. As noted above, history doesn't suggest that will be the case.

NASDAQ 100 (-0.92%) has felt the hardest tumble after looking so good in late August. It is still below the March low, the prior low for 2008. At least it is oversold . . .

Making a higher low attempt near 1200 the July 2008 low. The selling this month started a third leg lower and the bailout bounced it two weeks back after a significant new low for the year. After a move higher on the bailout announcement we anticipate another test of that low as SP500 tries again to put in a floor on this selling that start a year ago. The credit freeze is not helping the economy, and after the next bounce SP500 will help tell the story of when the economy recovers.

SP600 (+0.10%) put in a gain Thursday and a fraction Friday after an ugly selloff. Held interim support and is trying to bounce. Great. If it can, perfect. The triple failure at 400 in June, August and September is typically a bad indication, and this last failure really disrupted the pattern. Not a breakdown so it can work on a new pattern over a few weeks after the bailout plan.

Riding the financials, trying to make a higher low after the modest new low for the year, and that means the blue chips can still pull off a double bottom. That makes it the aberration among the indices, and as they other indices are in need of some help, some leadership from the Dow is welcome. Plenty of work to do as there is a range of overhead supply from 11,400 to 11,800. Digging out of a hole is work, but again, the Dow has the best pattern and thus the best shovel to do it.

The near term action is riding on when a deal is done. Not necessarily what deal is done; that will be mulled in the months after the announcement. A deal will bump the market. It may come this weekend, it may take until Wednesday. That means a lot of stress if it doesn't come this weekend before the Asian markets open, so there is pressure to get it done, and Congress was working on it until midnight Friday.

Again, expecting a rally on the news of a deal on the bailout. Will get what we can to the upside, watching how it reacts to resistance. After that we anticipate a turn back down as the market deals with the effects of the credit freeze on the economy and what is likely an inevitable slowdown in the aftermath. It survived spiking oil prices and started to show improving data in May through July. The housing market looks to have bottomed. Then it gets a worldwide credit freeze and that could be the killer that finally puts it into a technical recession just as Ireland, and as reported Thursday, New Zealand.

The key is when the market starts to factor in an economic recovery. The bailout plan will stop the bleeding and allow companies to function again. Then it is a matter of getting over the bruises and breaks and moving back to running speed. The extent of the damage is unknown. Oil prices are trying to rise and other commodities, though not their stocks, are showing strength as well. Gold is back up on inflation worries and solvency worries given the massive amounts of liquidity injected in the global economies. Still plenty of landmines to avoid after the package is passed. We certainly don't want to do anything to stymie businesses getting back to buying capital equipment and ginning up the economy as in 2003. Some tax credits and other tax incentives after the bailout package would be very welcome with respect to getting the growth in the economy back and thus getting jobs back up.

There are still many beguiling upside patterns out there. While we believe a bounce will be followed by another test lower, it may take a few weeks to do that. If the belief in a recovery is weak, however, it may happen quickly after an initial bounce following the bailout announcement. The market will have to show the way but we are anticipating the latter followed by several weeks of trying to put in another floor to rally from.

We cannot ignore the good patterns and we won't. We just won't pile into them all at once but move in piecemeal if we get good moves. Given we anticipate a pop and drop we prefer seeing if the breakouts test and hold on the market drop following the bailout bounce. If they do and start back up that is the perfect time to enter them. Again it depends upon how the market reacts to the bailout. No rush. Just have to be methodical.

Downside is also a must consideration in this climate as a bounce higher that stalls and starts to reverse on volume indicates more selling to come. The index ETF's are a good way to play that. We will have to let the market make its bounce and see where it stalls. Near the 50 day EMA on SP500 is a possibility. We can anticipate that and be ready for downside from there, but again, we will simply have to see how the market responds to any bailout package, ready to trade the initial move and then the test. After that we see how the strong patterns held up and whether they indicate that more upside is ahead by resuming their moves after a test.

Everyone would like to see the travails end with the bailout announcement but as history suggests, that is not the case. Again, the bailout applies a tourniquet to stop the bleeding and save the life. The patient still has to heal and may need some additional medical treatment to get through the healing process and back up to full speed. Thus we need to be ready for some range trading as well as another selloff at some point to test that new low for the year. Not everyone's favorite kind of market, but if that is what the market is giving we need to adjust to it and take it.

Support and Resistance

NASDAQ: Closed at 2183.34Resistance:The 10 day EMA is 21942202 is the January 2008 low2261 is a March 2008 interim low2286 is the first April 2008 gap up point.The 50 day EMA at 22872300 is some resistance2340 from the March 2007 lowThe 90 day SMA at 23432370 from the April 2006 peak2372 is the trendline from the summer 2004/July 2006 lows, Q4 2005 consolidationThe 200 day SMA at 23742378 is the mid-February peak; 2379 from the October 2006 peak2386 is the August 2007 intraday low2388 is the June 2008 low2392 is the April 2008 peak2419 is the January 2008 peak and the early February peak

Support:2167 is the July 2008 low2155 is the March 2008 low2070 is the recent September 2008 low2043-47 from the July 2006 low and October 2005 low2020 from January and April 20051912 from April 2005

S&P 500: Closed at 1213.01Resistance:1215 is the July 2008 closing lowThe 18 day EMA at 12221239 is the 2002/2003 up trendline1244 is an August 2005 peakThe 50 day EMA at 12531257 is the March low1270 is the January low1285 is the recent July peakThe 90 day SMA at 12861313.15 is the August 2008 peak1317 from the February low1324 is the April low1331 is the June lowThe 200 day SMA at 13361362 is an ancient trendline

Support:1200 is the July 2008 intraday low1176 from the Q4 2005 lows1167 is the January 2005 low1154 from the May 2005 lows1142 is the 2005 closing low1133.50 is the September 2008 low1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.

Dow: Closed at 11,143.13Resistance:11,317 from March 2006The 50 day EMA at 11,36011,388 is the prior August lowThe 90 day SMA at 11,60811,635 is the January intraday low11,670 is the May 2006 intraday high; 11,642 closing 11,695 is the 2004/2005 up trendline11,731 is the March 2008 low 11,867 is the August 2008 peak12,050 from the March 2007 12,070 from the early February 2008 lowsThe 200 day SMA at 12,16712,250 from late March 2007 lows

Support:11,061 from February 200610,962 is the July closing low10,827 is the July 2008 intraday low10,459 is the recent September 2008 low10,215 from Q4 200510,100 to 10,000

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.